Who do you subsidise?

Customers with a lower consumer surplus end up subsidising those with a higher consumer surplus

One basic rule of pricing is that it is impossible for all buyers to have the same consumer surplus (the difference between what a buyer values the item at and what he paid). This is because each buyer values the item differently, and is thus willing to pay a different price for it. People who value the item more end up having a higher consumer surplus than those who value it less (and are still able to afford it).

Dynamic pricing systems (such as what we commonly see for air travel and hotels) try to price such that such a surplus is the same for all consumers, and equal to zero, but they never reach this ideal. While the variation in consumer surplus under such systems is lower, it is impossible for it to come to zero for all, or even a reasonable share of, customers.

So what effectively happens is that customers with a lower consumer surplus end up subsidising those with a higher consumer surplus. If the former customers didn’t exist, for example, the clearing price would’ve been higher, resulting in a lower consumer surplus for those who currently have a higher consumer surplus.

Sometimes the high surplus customer and the low surplus customer need not be different people – it could be the same person at different times. When I’m pressed for time, for example, my willingness to pay for a taxi is really high, and I’m highly likely to gain a significant consumer surplus by taking a standard taxi or ride-hailing marketplace ride then. At a more leisurely time, travelling on a route with plenty of bus service, I’d be willing to pay less, resulting in a lower consumer surplus. It is important to note, however, that my low surplus journey resulted in a further subsidy to my higher surplus journey.

When it comes to markets with network effects (whether direct, such as telecommunications, or indirect, like any two-sided marketplace), this surplus transfer effect is further exacerbated – not only do low-surplus customers subsidise high-surplus customers by keeping clearing price low, but network effects mean that by becoming customers they also add direct value to the high surplus customers.

So when you are pleasantly surprised to find that Uber is priced low, the low price is partly because of other customers who are paying close to their willingness to pay for the service. When you pay an amount close to the value you place on the service, you are in turn subsidising another customer whose willingness to pay is much higher.

This transfer of consumer surplus can be seen as an instance of bundling, but from the seller’s side. Since a seller cannot discriminate effectively among customers (even with dynamic pricing algorithms such as Uber’s surge pricing), the high-surplus customers come bundled with the low-surplus customers. And from the seller’s perspective, this bundling is optimal (see this post by Chris Dixon on why bundling works, and invert it).

So the reason I thought up this post is that there has been some uncertainty about ride-hailing marketplaces in Bangalore recently. First, drivers went on strike alleging that they weren’t being paid fairly by the marketplaces. Then, a regulator decided to take the rulebook too literally and banned pooled rides. As i write this, a bunch of young women I know are having a party, and it’s likely that they’ll need these ride-hailing services for getting home.

Given late night transport options in Bangalore, and the fact that the city sleeps early, their willingness to pay for a safe ride home will be high. If markets work normally, they’re guaranteed a high consumer surplus. And this will be made possible by someone, somewhere else, who stretched their budget to be able to afford an Uber ride.

Think about it!

Parking and congestion

It is not too rare to see Indian politicians and policymakers talking about imposing congestion charges on Indian roads in order to control traffic.

The basic idea is pricing based on demand and supply – since supply of road space is constraint, and demand is increasing by the day, the use of roads in certain parts of cities (typically central areas) gets priced. This way, not only does this control the flow of traffic, but also nets revenue for the city.

In Indian cities, thanks to the numerous “cross roads” which can provide arbitrage opportunities, congestion pricing is hard to implement. However, there exists a fairly simple way to price road space and dissuade people from using private transport – charging for parking.

It’s such a simple and intuitive concept that it is a wonder that we need this blogpost (and this) at all. And in some ways, we can think of charging for parking as the “dual” of charging for congestion. Instead of charging for road space through the journey, we charge the ends.

This is of course an imperfect solution – it still doesn’t prevent people from driving through an already congested area with high parking charges, but it is at least a start.

The incremental impact of charging for parking can lead to a reasonable dip in traffic. It will also prevent people from moving around slowly in search of a parking spot (anyone who’s seen congestion on Brigade Road in Bangalore will attest to this). And as anyone who has tried to park a two wheeler in Bangalore will tell you, monitored parking spaces result in significantly better utilisation of parking space.

And then there are benefits to the government. The city government makes money (Takshashila had a paper on this a while back, but I’m not able to find it now) which is not small. The ability to regulate and charge for parking lets people know that the city government is capable of regulating traffic.

What’s more – once basic pricing is introduced, more innovative solutions will be found by the market. We might have apps that lead to pre-booking of parking space at your destination. We might have apps that lead parkers to the nearest empty parking space, thus cutting congestion on roads. We might even have a marketplace for parking space! All of this must be compensated for, of course, and unless parking itself is charged for, such businesses cannot function.

Other airlines to bail out Spice Jet?

In a rather bizarre move, the Directorate General of Civil Aviation (DGCA) has directed airlines to not charge “exorbitant fares” for passengers stood up upon cancellation of Spice Jet flights. This is a rather bizarre idea and effectively amounts to asking other airlines to partially bail out Spice Jet.

Essentially when an airline is in trouble, passengers are loathe to book tickets on it, for they know that the chances of their flight getting cancelled is high. A cancelled flight usually means either cancelling the trip itself or rebooking on another airline (sometimes airlines have arrangements with each other for taking on passengers on cancelled flights, but currently no other airline in India will give credit to Spice Jet). Either ways, it is a costly affair for the passengers.

By directing airlines to not charge “exorbitant fares”, and assuming that such a directive will be followed (very likely that this directive is meaningless for this is the busy season and other airlines are likely to be booked out), the total cost of booking a ticket on Spice Jet actually comes down, for the charge a customer will have to incur for re booking on another airline for a cancelled Spice Jet flight is likely to be reduced. And thus passengers will not abandon Spice Jet at the rate at which they normally would. And since other airlines are taking a hit on the spot fares they could potentially charge (in the absence of this directive) they are effectively subsidising and “bailing out” Spice Jet!

The other problem is that in the absence of market mechanisms (which the price cap effectively curb), how will other airlines allocate their remaining capacity among all the passengers who have been stood up by Spice Jet? Some arbitrariness is likely to ensue and passengers are likely to be left more disappointed!

The government had started off by handling the Spice Jet case rather well, as Devika Kher has argued here. However, of late, the wheels of the DGCA seem to have come off in his aspect, and there seems to be a concerted attempt to let Spice Jet stay afloat against the wishes of the market. The Airports Authority of India and oil companies have been asked to extend credit for fifteen days.

It seems Devika spoke too soon!

Uber, Meru and Service Taxes

The use of arbitrary barriers in regulation, like the Rs. 10 lakh limit on Service Taxes is counterproductive and can lead to a non-level playing field. More importantly such barriers encourage small-scale operations which can act against efficiency

A couple of months back, the Service Tax Department slapped a notice on Uber, demanding that the cab aggregation service pay service tax on its revenues. Cab services fall under the service tax net, and recently other cab service providers such as Meru and Mega have started adding a service tax component to their bills.

What queers the pitch in the case of Uber is who pays, and whether they pay at all. Uber claims to be an aggregation platform, bringing together cabbies and passengers, and says that it is the cabbies who are in charge of paying service tax on the revenues they make through the platform. From the Tax Department’s perspective though, going after thousands of cabbies demanding taxes is not very feasible, so they are trying to get Uber to pay the service tax.

More importantly, Service Tax becomes payable only if the annual revenues from the service cross Rs. 10 lakh and it is unlikely that too many of Uber’s cabbies will cross that threshold. So if we were to look at Uber strictly as an aggregator (which it actually is), it is unlikely that any service tax can be collected on its services!

What it also means that this gives platforms like Uber an unfair advantage over companies such as Meru which own their taxis – the latter’s revenue is much more than Rs. 10 lakh per annum and thus service tax has to be paid on the entire revenue! And this means that the playing field when it comes to taxi services is not level – for it is cheaper for an individual running a single taxi to offer service rather than a company offering a fleet.

This is similar to regulations in manufacturing that make it much more expensive (in terms of enhanced labour regulations and disclosures for companies beyond a certain size) for larger companies to operate vis-a-vis smaller ones. Even in the proposed relaxation of labour laws, a number of relaxations are to do with the minimum size of a company for doing the disclosures, and not with the easing of regulations themselves. All that it means is that just the threshold is raised – it becomes easier for companies to grow beyond their current levels of inefficiency, but they will soon hit a new level of inefficiency!

The problem for all this is the arbitrary fixing of slabs. An ostensible reason for fixing the minimum slab for service tax at Rs. 10 lakh is that enforcement for people earning less is going to be difficult. But as can be seen in the Uber case, this can lead to inefficient structures of industrial organisations, by keeping them small, and is hence not prudent. The government would do well to remove such arbitrary numbers from its regulation!

The other thing about service tax is that once your income crosses Rs. 10 lakh, you pay service tax on your entire income rather than the excess over 10 lakh, which is how income tax is structured. This is again inefficient, for someone who is making Rs. 9.8 lakh is now dissuaded from taking new business since it can literally subtract value! Another reason for arbitrary barriers to go.

Why app based taxi services should not be banned

The move towards banning Uber and other app-based taxi services is devoid of logic on several counts

Writing during the Takshashila Hudson conference on India’s growth I had argued that an easy way to increase the level of business activity in the country, and thus GDP was by means of reducing transaction costs. Transaction costs are costs borne by buyers of a good or Service which don’t accrue to the seller.

The thing with transaction costs is that they introduce friction in the market – the cost ends up reducing both the market clearing price (as it accrues to the seller) and the market clearing quantity. And transaction costs are usually to no ones gain and thus reducing them is a quick and pareto optimal method of boosting GDP.

In this regard, the government must encourage all means that result in reduction of transaction costs. For example better road and rail network significantly reduce the transaction cost of moving goods and people. Removal of interstate taxes on goods and services results in more optimal setups of warehouses and plants.

Similarly apps such as Uber play an important role in reducing transaction costs in the local taxi market. By reducing the distance and time to be traveled by the driver, and by reducing the amount of the the passenger has to wait for the cab, these services significantly reduce the cost of local transport and benefit drive and users alike.

Thus moves such as banning such services are utterly brainless and devoid of logic. Moreover such moves will dampen investor sentiment in India and kill off any positive vibes that have been generated ever since the current government came to power.

I hope better logic prevails and the government focuses on improving law and order (a public good that can further reduce transaction costs) rather than knee jerk actions like banning taxi services which seek to reduce transaction costs.

Implementation and rule of law

Draconian laws coupled with lax implementation deliver too much power to regulators. This makes the business environment unpredictable and makes it harder to do business.

Following the arrest for rape of a taxi driver who was hailed using the Uber app, the Delhi government has gone on to ban Uber. Not satisfied with that, it has gone on to ban all other app-based taxi hailing services (Ola and TaxiForSure are the other big ones). Following the incident last weekend, the government has suddenly decided to throw the rule book at these aggregators and accused them of running taxi services without a license. The point to note here is that until the weekend’s alleged rape, it seems that these businesses were all kosher.

A few months back Mint had an excellent piece (I hope I’ve got the link right) on the absurdities of some of India’s labour laws, and pointed out that most companies are in the breach of such laws. Essentially while the labour laws in India are not very short of being Draconian, what allows businesses to do business and people to go about their lives is lax implementation. And it seems that this issue of draconian laws and lax implementation is not restricted to labour alone.

The iconic Bangalore Club in Bangalore has had its liquor license withdrawn following a raid by the excise department last week. The trigger for this raid is alleged to be a case where a security guard of the club refused to let in the car of a police officer who was not carrying his membership card. This is alleged to have led to a series of cases which finally led to the excise raid and the cancellation of the license. It seems that before the police officer’s car was stopped, there was no violation of excise rules.

In a recent dispute on VAT, the Karnataka government has forced Amazon to stop storing third party goods in its “fulfilment centres”. There has since been back and forth on this and the commissioner of commercial taxes who implemented the order has since been transferred. It was initially expected that the Karnataka government would take the legislative route to clarify this tax dispute in the current Assembly session at Belagavi, but that seems to now be put on hold. Instead, it is likely that the laws are going to remain the way they are and Amazon will by “spared” on account of lax implementation.

Lax implementation of laws is a major impediment to doing business, for it removes predicability. Clear laws which are implemented well set down clear rules for businesses and there is little in terms of what is right or wrong. Such laws make it possible for businesses that choose to be “100% legal” to take a path where there is no ambiguity on their activities. Lax implementation, however, biases the playing field in favour of players who are willing to play on the borders of legality and who rely on lax implementation and benevolence by regulators to continue doing business which is technically illegal. Soon, this results in an equilibrium where everyone is in violation of some rule or the other and remains in business only due to the “benevolence” of regulators.

This implies that regulators who are in charge of implementing these draconian laws have enormous powers over the business they regulate, for any move by the business that the regulator does not like can be responded to by a throw of the proverbial rule-book. This places these businesses at the effective control of these regulators and helps perpetrate what Amit Varma calls the “mai-baap sarkar” – where you function solely due to the benevolence of the government or people acting on behalf of it.

Prime Minister Narendra Modi has stated that one of his goals is to improve the ease of doing business in India. As long as we do not have predictable and rule-based implementation of law, it results in giving significantly higher powers to the regulators, which makes the business environment unpredictable, and makes it harder to do business. If we have to improve our ease of doing business ranking to 50 (as stated by Modi), a necessary step is to implement each of our laws in letter and spirit, without any room for ambiguity. Of course this will lead to the diminishing of power of the regulators over their “regulatees”, but solving that is a political problem which the government ought to solve.

Mob courts and social media

The withdrawal of the invitation to former Tehelka editor Tarun Tejpal from the Times of India Lit Fest (to be held later this week) has been held up as a stellar example of “victory of social media over traditional media”. Tejpal, who has been accused of rape and is out on bail, was invited to be part of a panel discussion at the lit fest. However, following vehement protests in the social media, the invitation was withdrawn.

Tejpal’s rape case is sub-judice and this blog does not have an opinion on that. This blog also does not at the moment have an opinion on whether it is appropriate for on-bail undertrials to appear at public functions. What this blog is concerned about, though, is about how social media is helping give voice to large collectives of people to outrage and effect change in public life.

A couple of other examples are of relevance here. Last week, Nobel laureate and co-inventor of the double helix structure of the DNA James Watson announced that he was going to auction his Nobel prize medal to raise funds, for most of his sources of income had dried up following a politically incorrect comment he made in 2007 about the intelligence of black people. Then, about a year back, PR executive Justine Sacco lost her job after a tweet which was intended to be a joke went viral and she was accused of racism.

It has long been touted as a good thing that social media gives a vehicle for the “small”, whose voice was hitherto unheard, to come together with other similar “small” people and make enough noise that their opinion be heard. While the merits of such “democratisation of public airing of opinion” are undoubted (for example I’ve made most of my reputation thanks to blogging, a means unavailable to me say fifteen years ago), the concern is that too much importance given to comments on the social media can alter discourse and end up muffling voices (whether “small” or “large”) that have occasionally said something unparliamentary.

The big downside of such outrage and muffling is that it can lead people to stop taking risks in terms of what they say, for saying something even remotely unpopular or politically incorrect might suffice to be branded a villain, which can have crippling impacts on professional (and sometimes even personal) lives. I can actually imagine this leading to a dystopian world where every sentence you say is judged by “the people” for political correctness, where the utterance of a a single politically incorrect statement can result in instant death (of course I’m severely extrapolating here, and constructing a hypothetical dystopian world, so don’t let this blog post become an example of what it’s warning against!). In such a world, as one could imagine, people would only say things that they are absolutely sure that a majority of other people will agree with. People will talk less (not necessarily a bad thing in itself), but creativity itself will be stifled (Copernicus and Galileo come to mind) and there is a good chance that in such a world growth and development might come to a standstill.

I’m in no way proposing that the voice of the “small” be gagged (this blog is also one such voice), or to go unheeded. All I’m asking for is that we do not go the way of being ruled by the mob, in terms of making decisions that receive the highest shouts in favour. For one, the mob is not always right. Secondly, it might only be people on one side of the debate who are loud and vocal, and the other side might, for whatever reason, not be able to make its voice heard. The world simply cannot progress without some people making unpopular decisions or unpopular statements.

So the Times of India, if it didn’t see merit in calls for withdrawal of Tejpal’s withdrawal, might have argued that while the matter was sub-judice, the matter of discussion had nothing to do with Tejpal’s case and that he had enough to offer to make his presence a positive. Magazines could have given Watson writing assignments arguing that he has much to offer in terms of science writing and that one politically incorrect column doesn’t make him a “persona non grata”. Sacco’s employer might have argued that she was entitled to have a bad sense of humour (though given that she worked in PR this (bad sense of humour) is not a useful skill to have). Listening to the most vocal voices is not always good policy.

 

 

From STD Booths to Information Kiosks

An IT Action plan submitted to the first NDA government in 1998 had envisaged a plan to “turn STD/ISD booths to information kiosks”. Considering that this was at a time when most of India did not have even a basic dial-up connection to the internet, it can be thought to be pretty far-sighted.

The PIB notification says:

Internet access nodes to be opened by DoT and authorised ISPs in all district headquarters by January 26, 2000, and, until then, Internet access from the nearest node on local call rates; upgradation of STD/ISD booths into full-service ‘information kiosks’ offering e-mail, voice mail and Internet; and permission for the Railways, Defence, State Electricity Boards, National Power Grid Corporation as well as organisations like ONGC, GAIL and SAIL to use their fibre optic backbone to provide service to the public by interfacing with existing or new public networks.

In a speech in 2004, towards the end of his full term, then Prime Minister Atal Behari Vajpayee had mentioned the same idea. Speaking at the inauguration of the TIDEL Park in Chennai, he had said:

There is an urgent need to generate useful educational, commercial, and other types of content on the Internet in Indian languages. As an example, I would like to see information kiosks to become as common across the country as STD booths, where ordinary people can access e-mail in Indian languages and also receive useful information about programmes, schemes, and facilities made available by the Government, banks, and other institutions.

In 1998, after the panel had submitted its report, Vajpayee had set up a high-level ministerial committee to look into the recommendations and come up with an implementation plan. I’m not sure much came of it.

Speaking of STD booths and information kiosks, though, it is very interesting to see what New York is doing with its telephone booths. The Washington Post reports:

The city announced Monday that it had selected a consortium of advertising, technology and telecom companies to deploy throughout the city thousands of modern-day pay phones that will offer 24-hour, free gigabit WiFi connections, free calls to anywhere in the U.S., touch-screen displays with direct access to city services, maps and directions for tourists, and charging stations (for the cellphones you’d rather use). The devices will also be capable of connecting people straight to emergency responders, and broadcasting alerts from the city during emergencies like Hurricane Sandy.

This is very impressive. Rather than doing away with PCOs like they’ve done in the Netherlands, this seems like an extremely interesting way to make use of them. I hope we can implement some of these in India, too. Considering that it was under a BJP government that the STD Booth to Information Kiosk idea first came up, I hope that the current government takes steps to implement it.

Regulation in capital cities

David Henderson notes that taxicab fares in Washington DC are much lower than anywhere else in the US, and for this he mentions the fact that Congressmen are frequent taxicab consumers in DC, and thus oppose any move to restrict supply, as is the case in other American cities.

But, I tell my students, there is one big counterexample: Washington, D.C. Why? Because Congress has a lot of say over the running of the D.C. government. So here the consumers, whose ranks include Congress and Congressional staffers, have a great deal of leverage over the regulators. Result: No way will Congress cooperate in artificially restricting supply and driving up cab fares that they themselves pay. That’s why cab fares in D.C. have traditionally been so low compared to fares for a given distance and time in other U.S. cities.

By that logic, Delhi and other state capital cities should have great public transport and infrastructure since MPs and MLAs are consumers there, and they wouldn’t want to impose higher costs on themselves. Why hasn’t that happened?

The simple answer is that as far as “government servants” in India are concerned, there is private provisioning of such goods. Thus the state takes care of accommodation and transport for these people. Since they live in a concentrated area, such areas are much less likely to suffer power cuts compared to the rest of the city. If you are a more senior government officer (of the grade of minister or chief minister or prime minister, say), you even get right of way on the roads and are not stopped by traffic.

Because we have elected to solve these problems for “government servants” in India by private provisioning rather than public provisioning, such “servants” are not consumers like anyone else. And thus, their presence in a city has no impact on public goods in the same city!

The Catalan Referendum

The results of the Catalan “informal referendum” are in, and show that over 80% of the respondents in the referendum have indicated a “Yes, Yes”, which means they want an independent Catalunyan nation. Of course, as pointed out here last weekend, this referendum doesn’t mean a thing, for there is significant selection bias in voting – for people in favour of secession would have had a much higher incentive to turn up on Sunday compared to those that were against.

So what does the Spanish PM Mariano Rajoy do now? Though this vote means nothing, one thing the “massive majority” does is to strengthen the case for the Catalans to press for a more formal referendum, one that is recognised by the Spanish Parliament. What this “massive majority” also does is to embolden the leaders of the Catalan independence movement towards becoming more hardline in their demands.

Spain can ill afford to lose Catalunya, for that is one part of the country whose economy isn’t as badly wrecked as that of the rest of the country. In fact, given complications in terms of membership of the EU, it may not actually be in Catalunya’s interest to be an independent nation – though that is another story. The best solution going forward would be what a referendum would have termed a “Yes, No”, that is to give Catalunya more autonomy as a “state” (right now it’s an “autonomous region”) within Spain.

Other regions of Spain such as the Basque Country have much more control over their finances than Catalunya does, and the Spanish government would do well to make such federalism uniform and give Catalunya similar powers. This would help maintain status quo over national identity, while conceding to the Catalans their biggest demand which is that too much of their tax money is going to fund the rest of Spain. Of course the rest of Spain will take a hit in terms of finances, but it can be worked out so that it is a gradual process and not sudden.

It is also worth examining the reasons behind the current wave of Catalan nationalism. There are two factors – firstly the Catalans resent that their tax money is being spent on the rest of Spain. When this combines with the fact that Catalunya is culturally different from the rest of Spain, and harbours an anger towards Madrid for what can be described as three centuries of “Castilian imperialism”, this leads to secessionist tendencies.

There are important lessons to be learnt from this for other countries which are also multicultural, and where one part (which represents a “different culture”) is significant superior to the other economically. There can be only one solution to keep such countries united – greater federalism, and to give the culturally-different-economically-superior regions belief that they are not being controlled by the “centre”. It is time for multicultural countries to embrace this rather than pretending to rule under the assumption that they are monocultural, and with an iron fist.